Speaker 1: We'll gan to trillions. I'm Joel Webber and I'm Americ
Speaker 1: Bell tunis Eric. Today we're gonna talk about something called
Speaker 1: direct indexing. What is that? Direct indexing is sort of
Speaker 1: a it's a newer, fresher name for what was previously
Speaker 1: called a separately managed account, and institutions use this a
Speaker 1: lot where and when I wrote my book on the
Speaker 1: e t F world and how institutions use them, shameless plug,
Speaker 1: shameless plug, it's called The Institutional EF. It is available
Speaker 1: on Amazon. But let's move on. UM, I was like,
Speaker 1: why don't big pensions just by the e t F. Well,
Speaker 1: they can go and get the SMP done for even
Speaker 1: cheaper than the e t F. So separately managed to
Speaker 1: accounts come up in my research just terms you just
Speaker 1: buy all the stocks directly and you let a black
Speaker 1: rock just do it. They it's it's almost like your
Speaker 1: own private e t F and you don't have to
Speaker 1: go to the public pool down the street, and institutions
Speaker 1: like that. It's cheaper, and ultimately the problem with that
Speaker 1: is in order to get at that pricing, you would
Speaker 1: need a hundred million dollars, So it was really an
Speaker 1: institutional thing. The more money you have, the lower you
Speaker 1: get charged. That's just generally how investing works. And direct
Speaker 1: indexing has now come along with technology and sort of
Speaker 1: said hey, let's democratize this and bring it to advisors.
Speaker 1: And there's a couple advantages they think are going to
Speaker 1: appeal to advisors. There's some competition with mutual funds and ets,
Speaker 1: which I think, with a heart of our discussion, some
Speaker 1: have I actually have heard the term E t F
Speaker 1: killer for direct indexing because obviously if you use this,
Speaker 1: you wouldn't use an E t F or you might
Speaker 1: use them together. Um, so I thought, you know, we
Speaker 1: should explore this. We recently wrote a note about it
Speaker 1: where he went through some of the advantages like a
Speaker 1: tail the tape between E t F and direct indexing.
Speaker 1: But E t F s aren't all who this competes with.
Speaker 1: But there's tax benefits and customization benefits which will go over.
Speaker 1: But direct indexing is kind of if E t F
Speaker 1: are the new kid on the block, this is sort
Speaker 1: of the new new kid on the block in terms
Speaker 1: of investment products. So to help us understand them, we're
Speaker 1: joined by Morgan Barna of Bloomberg Intelligence and also Brian
Speaker 1: Langstrat who's the CEO of Parametric? What's Parametric the largest
Speaker 1: direct indexing platform company at three billion dollars. So if
Speaker 1: Parametric or an et F, fish or I think you'd
Speaker 1: rank fourth just to sort of say this is how
Speaker 1: big this is getting. So three billion is a ton
Speaker 1: of money. Um. That that said, I think, A that's
Speaker 1: way bigger than most others. And B direct indexing and
Speaker 1: SMAs are obviously very linked and like s m as
Speaker 1: are big, like black Rock has over a trillion in
Speaker 1: s m as. So it's a it's a it's kind
Speaker 1: of a gray area on where direct indexing begins and
Speaker 1: s m A ends. But let's just say that Parametric
Speaker 1: is the biggest of this new wave this time on
Speaker 1: trillions exploring direct indexing. Brian Morgan welcoming trillions. Thanks joining So, Brian,
Speaker 1: I want to start with you. Where did this space
Speaker 1: come from? Yeah, So, Parametric started what is called erect indexing,
Speaker 1: or building a separately managed to count to target an
Speaker 1: index and then customize it. So it's been around for
Speaker 1: our shop for twenty seven years. We think we were
Speaker 1: one of the first, if not the first, But when
Speaker 1: we started it, there wasn't a lot of conversation about
Speaker 1: it and how did it come to be. Yeah, Um,
Speaker 1: we had a family office client who had struggled with
Speaker 1: that kind of age old dilemma of hiring and firing
Speaker 1: active managers, comparing them to a passive universe, one growth,
Speaker 1: one value, and together with their consultant, came with the idea,
Speaker 1: instead of hiring and firing and evaluating these active managers
Speaker 1: equity managers, let's buy the universe we compare themselves to.
Speaker 1: And the really innovation they had gonna have some money
Speaker 1: to be able to say I'm not buy the universe. Yeah, well,
Speaker 1: I think you can build and manage a separately managed
Speaker 1: to count the tracks and index for I mean, it's
Speaker 1: not a mass affluent product. It's not a product for
Speaker 1: the masses. But you know, with a with a portfolio
Speaker 1: size of a quarter of a million dollars, half a
Speaker 1: million dollars, a million dollars with really consistent tracking here,
Speaker 1: so you have the same pre tax experiences that universe
Speaker 1: and index a custom index, the SMP five, the Rustle three. Um.
Speaker 1: The idea that they had was instead of just tracking
Speaker 1: the universe, and it was their idea, not ours. Uh,
Speaker 1: let's do it. But Let's be cognizant of the tax impact.
Speaker 1: Let's not just rebalance. Let's not trade the securities when
Speaker 1: if it comes out of the index er and it
Speaker 1: let's not Let's think about where the gains are, where
Speaker 1: the losses are in the portfolio. That kind of customization
Speaker 1: requires you to do it on a separate account basis,
Speaker 1: portfolio by portfolio. Let's um and then let's let's let's
Speaker 1: have two objectives, track that universe and really minimize the
Speaker 1: tax impact of the portfolio. They brought the idea to us.
Speaker 1: We said that was interesting. We were a small firm,
Speaker 1: didn't have a lot to do UM and we soon
Speaker 1: found that a lot of the people were interested in
Speaker 1: the idea. Could you capture the benefit of indexing, the
Speaker 1: broad diversification, the consistent performance, the low costs, but you
Speaker 1: add additional value through customization. And there really are three
Speaker 1: types of customization that drive this. Now. Tax is still
Speaker 1: the biggest E. S G and R I, re sponsible investing,
Speaker 1: and then creating your own bespoke exposure, something that's not
Speaker 1: available in a typical pooled, commingled vehicle. And you know,
Speaker 1: for the last twenty seven years, it's a little bit
Speaker 1: amusing to me to think about this as the new
Speaker 1: kid on the block. I was, I was the portfolio
Speaker 1: manager twenty seven years ago on the account. Uh. And
Speaker 1: hundreds of billions of dollars later. Uh. It's become quite
Speaker 1: an interesting alternative for some. I wouldn't call an E
Speaker 1: t F killer for some versus E t F and
Speaker 1: index mutual funds. It's interesting though. Labeling matters, Like I
Speaker 1: compared direct indexing is to E t F some mutual
Speaker 1: funds as smart beta is too quantitative. Quantitative has been
Speaker 1: around for a long time, right, you know, decades, but
Speaker 1: they that smart beta label made it seem new and
Speaker 1: fresh and democratized. This so I think that is why
Speaker 1: it tends to be looked at as the new thing. Yeah,
Speaker 1: and tax regimes come and go, you know, to act
Speaker 1: rates increase, they decrease people's sensitivity to taxes. Technology has
Speaker 1: made it more more easily done, more easily understandable. But
Speaker 1: we've been hammering away at this for for for two
Speaker 1: and a half decades. What's changed in that time in
Speaker 1: terms of what what the vehicle actually looks like? Yeah,
Speaker 1: not a lot um. It's really like to say, a
Speaker 1: parametric we only have one or two or three good
Speaker 1: ideas in thirty years, and this idea is pretty good. Yeah. Well,
Speaker 1: there's people I think that they have good ideas every
Speaker 1: day about what to invest, and we don't um the idea.
Speaker 1: It's a very very simple idea, and that is capture
Speaker 1: what we all know inherently to be the value and
Speaker 1: power and the compelling logic of index based investing. But
Speaker 1: do it in a separate account. And once you cross
Speaker 1: that line from commingled to separate account, the world opens
Speaker 1: up to you in terms of customization. You can fund
Speaker 1: with the pre existing securities. You don't have to fund
Speaker 1: with cash, so you don't have to realize the gains
Speaker 1: on the way in if they're there. That's huge for
Speaker 1: many people. You can do loss harvesting. Loss harvesting is
Speaker 1: probably the most commonly mentioned benefit, but it's it is
Speaker 1: not the end all. It is a lot other You
Speaker 1: can do a lot of other tax management, gifting of
Speaker 1: securities up and then you can build the exposure that
Speaker 1: might be a little bit different than the index. You
Speaker 1: can put a responsible screen on it. You can you
Speaker 1: can say I like to tilt toward value. So the
Speaker 1: technology to build and understand how you manage those exposures.
Speaker 1: Continues to evolve. Uh, we continue to innovate around the
Speaker 1: edges about that central core ideas the same as it
Speaker 1: was in two You just had a strategic kind of
Speaker 1: alignment with Eden Vans. What does this do for the
Speaker 1: parametric I mean you've you've been part of Eating Vans
Speaker 1: for a long time now, but um, this new alignment
Speaker 1: with the fixed income business and the technology, what what
Speaker 1: are you looking forward to? Yeah? And and that just
Speaker 1: I want to piggyback off that, which is that this
Speaker 1: is I've always heard direct indexing is an equity thing,
Speaker 1: right is it mostly for the equities? But can you
Speaker 1: do fixed income also? I guess can you talk about
Speaker 1: what part of your portfolio can you direct indexing? Right now? Yeah?
Speaker 1: So if we think about direct indexing buying and holding
Speaker 1: a broadly diversified exposure, a fixed income exposure and equity exposure,
Speaker 1: or maybe both in the same account. Uh, they're the
Speaker 1: most popular fixed income type solution in that vein or
Speaker 1: laddered portfolios, ladder municipal bond portfolios, ladder corporate bond portfolios.
Speaker 1: It's a business that has been built up within Eating
Speaker 1: Vance since two thousand and eight I think may have
Speaker 1: started a few years later, but recently we combined those
Speaker 1: products and that investment technique and those investment skills in
Speaker 1: the technology with Parametry who kind of redrew the boundaries
Speaker 1: within Eating Vance. And now we're coming to market with
Speaker 1: both and we always did before, but we're doing in
Speaker 1: a coordinated way. We're investing in the systems in the technology,
Speaker 1: we're investing in the digital tools around it, we're investing
Speaker 1: in the performance reporting. And that's really what it means
Speaker 1: to us to kind of reshape the eaton Vance business
Speaker 1: aiming at this very exciting growth market. There's not a
Speaker 1: lot of growth opportunities in the investment management business. As
Speaker 1: you guys know, Uh, the investment management businesses shift thing
Speaker 1: toward rules based, systematic, low cost, clear value added products,
Speaker 1: away from the traditional value proposition of alpha or active management.
Speaker 1: And we've got a great franchise across that. So let's
Speaker 1: bring this up. Let's what we'll tackle this in a
Speaker 1: couple of blocks. Firsts, customization. That's a big benefit here,
Speaker 1: it's the only benefit. Well, the tax thing that's customization. Okay, well, okay,
Speaker 1: Well we'll break customization into two parts. Picking the stocks
Speaker 1: and the tax. When I hear this proposed, it sounds
Speaker 1: so good. Hey, you don't like this company? Does this?
Speaker 1: Pull it out? It's like an E s G kind
Speaker 1: of customization. Or if you work at Apple and you
Speaker 1: have a lot of their stock, you can pluck that out.
Speaker 1: Here's the thing, though, we all know that that makes
Speaker 1: the client the active manager. Now and we all know,
Speaker 1: like you take the I Shares Social Index, it's underperforming
Speaker 1: the SMP by over ten years. Are people gonna be
Speaker 1: able to stomach that if they don't uh, completely tie
Speaker 1: or beat the SMP, because that is a for whatever reason,
Speaker 1: the SNP is like God or you know, in the
Speaker 1: in this in portfolios, and if you customize, your odds
Speaker 1: of beating it are pretty low. You become an active manager.
Speaker 1: And we know it's hard. So how how does that work? Yeah,
Speaker 1: so you've you've hit the central trade off of direct indexing,
Speaker 1: and that is you accept a certain amount of deviation
Speaker 1: what we call a quant manager tracking air versus the index,
Speaker 1: in order to avail yourself of the customization. You do
Speaker 1: it every time you harvest a loss. You do it
Speaker 1: every time you put it in in the s G and
Speaker 1: r I. Every time you tilt, and so the investor
Speaker 1: has to believe we can show that over time those
Speaker 1: small differences from those customization decisions, those variances versus a
Speaker 1: pure tracking index are worth it to them. They average
Speaker 1: out to be very low on a pretax basis, and
Speaker 1: the after tax or the E S g R I
Speaker 1: benefit comes through very dramatically, and we can show that
Speaker 1: now over twenty five years. So when you deviate from
Speaker 1: an index, there's a lot of different ways to do it.
Speaker 1: If I'm tilting toward a factor or a sector or
Speaker 1: an industry read well, then I'm probably going to see
Speaker 1: myself with long periods of outperformance or under performance. But
Speaker 1: if my entire deviation from the index can be understood
Speaker 1: as very small mis waitings on an individual stock based
Speaker 1: what a risk model would call idiosyncratic risk, they average
Speaker 1: out over time to look like the index. So if
Speaker 1: you look at a Parametric composite over twenty years, the
Speaker 1: pre tax performance almost indistinguishable from the pre tax performance
Speaker 1: of the index. It's the after tax, but we're trading.
Speaker 1: That's our currency tracking error or mistracking versus customization benefit,
Speaker 1: and our engineers at Parametric are working on that from
Speaker 1: a thousand different angles. But you're right, you have to
Speaker 1: be willing to accept a difference in order to avail
Speaker 1: yourself of the customization. Now, obviously, with with an e
Speaker 1: t F, let's just say the sp F und you
Speaker 1: can now get that for four three basis points, probably
Speaker 1: two and one in the next couple of years. If
Speaker 1: I can get a whole portfolio for under ten bits
Speaker 1: at this point ten basis points. Um, how much does
Speaker 1: this cost? And how hard is it to dislodge such
Speaker 1: a compelling value proposition, which is this sort of like
Speaker 1: et F portfolio, especially from the advisor's mindset, because um,
Speaker 1: that's good for them, lower their fund fees more their
Speaker 1: fees is intact. Yeah, no, we love to think about
Speaker 1: the trade off there. So let's just make it a
Speaker 1: Let's say it cost you thirty basis points for a
Speaker 1: direct index portfolio and you can get the e t
Speaker 1: F for free. All right, let's just start with it.
Speaker 1: Thirty basis points is are bogey. We gotta add thirty
Speaker 1: basis points and value over time, otherwise you need to
Speaker 1: go do something else. And the majority of the d
Speaker 1: F investors should stick with ETFs. But if you find
Speaker 1: yourself in a position where you have pay high taxes,
Speaker 1: you're fund with pre existing securities, you've got a long
Speaker 1: time horizon, you're terriably inclined. We can add a hundred
Speaker 1: and fifty two hundred basis points a year and after
Speaker 1: tax performance value above the return of an index. Uh
Speaker 1: So that's that's in my mind, one of the best
Speaker 1: tradeoffs and money management. How you take fifty basis points
Speaker 1: of tracking, are you get a hundred fifty basis points
Speaker 1: of excess return? You pay thirty basis points for it.
Speaker 1: Any quantitative manager out there, we think that puts us
Speaker 1: in the top courttile top death style. That's the trade off.
Speaker 1: But it but it isn't just the after tax performance business.
Speaker 1: If we've been able to build a round a pre
Speaker 1: existing holding or a series of holdings and defer the
Speaker 1: gain and not for a long term. If they have
Speaker 1: charitably inclined, so every year they want to give five
Speaker 1: percent of that portfolio two percent to charity, and we
Speaker 1: can go into the separate account and we can select
Speaker 1: the most advantageous tax lots, the tax lots that have
Speaker 1: the largest embedded unrealized gain and give those. Then the
Speaker 1: value starts to add up. So the trade off of
Speaker 1: our fees and the fees inherent in the portfolio, and
Speaker 1: the cost versus the benefit, we think is very compelling,
Speaker 1: not to everyone investors of size investors, uh you know, uh,
Speaker 1: with tax sensitive investors who have long time horizons, on
Speaker 1: and on and on. I think the majority of the
Speaker 1: money in ETFs gually the taxable money should be in
Speaker 1: a direct ecnticcy, but maybe not. The majority of the
Speaker 1: investors in ETF should be in direct indexing. So when
Speaker 1: when clients and investors come to you, how much of
Speaker 1: what you're offering is literally out of the box solution
Speaker 1: off the shelf solution versus something that's totally customized for them,
Speaker 1: And like are you looking at like, hey, I've got
Speaker 1: some mutual funds that have just been kicking around forever.
Speaker 1: Can you absorb those and do something with them? Yeah?
Speaker 1: So there, there, you've just hit on the difficulty in
Speaker 1: running the business. So commingled vehicles ETF. Some mutual funds
Speaker 1: are great for money managers that you can just the
Speaker 1: leverage the economies of scale, the marginal costs wonderful custom
Speaker 1: Separate accounts are a lot of work. We have to
Speaker 1: customize on the way in. We have to customize during
Speaker 1: the management. Then we have to defend that customization and
Speaker 1: client service and performance reporting. So uh it is we
Speaker 1: do all of the things you talked about. The simplest
Speaker 1: example is you come to me with cash and you
Speaker 1: want to plain vanilla index or a standard index like
Speaker 1: the Rustle one, and you want simple loss harvesting. That's
Speaker 1: a pretty plain vanilla portfolio. We probably don't have to
Speaker 1: work hard to set that up. And if you understand
Speaker 1: how much cash am I bringing, you know we are
Speaker 1: Our minimums are two fifty dollars and many UH programs
Speaker 1: and platforms, so uh you know, we run about forty
Speaker 1: thousand individually separately managed accounts. They range from a billion
Speaker 1: dollar account for some of the wealthiest investors in the
Speaker 1: country down to to to UH portfolio that would be
Speaker 1: in the king And what percent are you dealing with
Speaker 1: the advisor versus a direct investor. Almost every UH portfolio
Speaker 1: that we manage comes with an advisor. And I think
Speaker 1: you hit on the point. One thing that direct indexing
Speaker 1: does above and beyond this after tax performance value and
Speaker 1: customization value relative to its fees is it becomes a
Speaker 1: tool for the advisor to do value added wealth management.
Speaker 1: So it's good for the client, but it's great for
Speaker 1: the advisors conversation. They can create a portfolio that has
Speaker 1: real value that you can't just walk across the street
Speaker 1: and get another one that looks like it. You can't.
Speaker 1: You don't see an advertisement for it on the Super
Speaker 1: Bowl uh television where you think here's a branded et F.
Speaker 1: This is a bespoke portfolio created in concert with the
Speaker 1: advisor that solves a problem for the investor. Yeah, we'll
Speaker 1: say we um we I just went to Wealth Stack,
Speaker 1: which is that conference fintech ish. This is a big deal.
Speaker 1: And Morgan and I talked about this a lot. When
Speaker 1: we look at the tail of the tape is the
Speaker 1: technology and the value add Advisors are on the hunt
Speaker 1: for value add let's face it, because they better min Vanguard.
Speaker 1: Everybody's doing cheap advice. Now, Morgan, um, why don't you
Speaker 1: riff on this because I think you have the most
Speaker 1: knowledge about this sort of technological revolution going on in
Speaker 1: the advisor world. Yeah, I'm so interested in the way
Speaker 1: that it seems like parametric and eating vans are now
Speaker 1: so focused on the ability to scale accounts at a
Speaker 1: lower um, a lower access point, but in part create
Speaker 1: create efficiencies you can continue to really invest. There's this
Speaker 1: seems like such a period for investing in technology enables advisors.
Speaker 1: What how does that plan to the distribution um. The
Speaker 1: dilemma that I think in understanding this marketplace is how
Speaker 1: much of the marketplace for this type of investing is
Speaker 1: to do it yourself? Because there are tools that the
Speaker 1: investor can just log on and build these portfolios or
Speaker 1: a robo when they can hire someone, or are these
Speaker 1: tools that an advisor can use themselves in their practice
Speaker 1: to do it themselves. My belief after watching this for
Speaker 1: about twenty five years is that the market for the
Speaker 1: do it yourself investor, to do it yourself advisor is
Speaker 1: relatively small. Uh and that's talking my own book. We've
Speaker 1: seen the growth, we continue to see it. Maybe that
Speaker 1: will change, but the the tools are are improving. But
Speaker 1: the advice, the consultative, the defense, the ultimate fiduciary responsibility
Speaker 1: for the performance and any errors or that occurred to
Speaker 1: it need to land on a money manager. So most
Speaker 1: of the fintech firms. We had our head trader leave
Speaker 1: Parametric twenty some years ago and start a firm to
Speaker 1: bring direct indexing technology directly and put it on the
Speaker 1: desk of the advisor. They eventually pivoted away. There are
Speaker 1: a lot of firms out there, but the our size
Speaker 1: and the size of our largest competitors in this space
Speaker 1: are people who actually manage the money. So our job
Speaker 1: and our goal and our vision is to continue to
Speaker 1: build technology that enables the advisor to use our services
Speaker 1: to the best advantage for themselves and the clients. And
Speaker 1: how about some of the turn key asset management players
Speaker 1: that are sort of developing these They already have huge
Speaker 1: advisor networks and this becomes defense for them from you know,
Speaker 1: clients you know considering either being bequested accounts or you know,
Speaker 1: considering self managing. How does that play? We view them
Speaker 1: as clients for us. We we work within many of
Speaker 1: the largest turn key asset management providers. We work within
Speaker 1: every wealth management platform, advice platform. UM. They can choose
Speaker 1: to build the technology themselves, hire someone else by a fintech,
Speaker 1: or they can work with a firm like ours. The
Speaker 1: market continues to expand there will be room for all
Speaker 1: of those business models. UM. You know, we'll see. And
Speaker 1: when I posted about this on Twitter, UM two advisors
Speaker 1: wrote back and just said, if I use direct indexing,
Speaker 1: does the client statement show five hundred stocks? And um,
Speaker 1: I remember looking. I did a every time that there's
Speaker 1: an election for president, I look at the financial disclosures
Speaker 1: of each candidate to find out like how they invest them. Yeah,
Speaker 1: and you look at like when you get them, and
Speaker 1: it's always like seven to thirty mutual funds, maybe some ETFs,
Speaker 1: but Donald Trump was like thirty five pages of stocks.
Speaker 1: And I I imagine something overwhelming coming to a client
Speaker 1: or an advisor, having that fear of handing them just
Speaker 1: pages and pages of equities and them not really understanding
Speaker 1: what they do. Because when you look at a couple
Speaker 1: of funds, you kind of understand where you are. Yeah,
Speaker 1: that partment feels like really old school. Actually, it's like
Speaker 1: a step back. That's what somebody said when we when
Speaker 1: we started in the broker dealer platforms and took our
Speaker 1: family office services and move them into the advice platform.
Speaker 1: Some of the initial advisors used to call it management
Speaker 1: by phone book because is the statements that would show
Speaker 1: up on their clients doorstep worth so thick. Uh. But
Speaker 1: the industry, the value is here. So the inventustry evolved
Speaker 1: one way to keep your job out, Yeah, exactly. The
Speaker 1: the the suppression of movement to our electronic confirms electronic statements,
Speaker 1: and the way that the savvy platforms and advisors compressed
Speaker 1: the parametric line or a competitors line into a single line.
Speaker 1: We've we've solved that for a large part um. We
Speaker 1: don't own all five hundred stocks in the SP's it's
Speaker 1: maybe a difference without a distinction, without a difference, we
Speaker 1: own maybe three twenty five or two hundred and fifty,
Speaker 1: and we'll let people cap it. There are competitors of
Speaker 1: eyes who who build direct indexing with seventy five twenty
Speaker 1: five names, you know, more than seven or eight mutual funds.
Speaker 1: But maybe I wasn't quite fair earlier. There's two trade
Speaker 1: offs between stepping away from an et F and moving
Speaker 1: to a direct indexing. First is that tracking or that
Speaker 1: mistracking difference that I think pays you very well. The
Speaker 1: second is complexity, and technology is helping us deliver this
Speaker 1: service cheaper with less of that complexity. Bird And but look,
Speaker 1: if you can add the kind of value that's shown
Speaker 1: here relative to the other opportunities that advisor and clients
Speaker 1: have to improve their performance. I think people increasingly get
Speaker 1: over those two things. One other thing, though, is that
Speaker 1: the e d F comes with this rapper, right, and
Speaker 1: that rapper is backed by the SEC and it's all
Speaker 1: sanctioned and everything. This is a step outside that world.
Speaker 1: How do you address that want to client? Yeah, I
Speaker 1: haven't seen that so much. I think that's already been
Speaker 1: done on the advice advisor's side. They've already educated their
Speaker 1: client on the value of an acseparately managed account. You know.
Speaker 1: I think that's a headline, a pretty interesting idea. But
Speaker 1: if you're really lift up the hood and say, look
Speaker 1: what I am owning here is three hundred of the
Speaker 1: S and P five hundred names, the you know, the
Speaker 1: most highly evaluated and followed companies in the world. I'm
Speaker 1: owning them in a fully transparent, separate account. If something
Speaker 1: happens to Parametric or happens, you know, they blow up.
Speaker 1: I still own those stocks tomorrow in my brokerage account.
Speaker 1: There's no black box, inherent secret mix here, there's no leverage,
Speaker 1: there's no there's very little trading. So I think people think, Okay,
Speaker 1: I don't have an SEC forty Act registration fund. But
Speaker 1: I get over that pretty quickly, let's talk about the taxes.
Speaker 1: So that obviously this tax advantage you said a hundred
Speaker 1: fifty points. I was talking to somebody who said, yeah,
Speaker 1: that that's good for a while, but it does run out,
Speaker 1: especially if the market keeps going up. Obviously, with the
Speaker 1: market going up, finding losses is hard, and I think
Speaker 1: that's why in twenty team we saw a huge dramatic
Speaker 1: move of flows because people realize some gains, and mutual
Speaker 1: funds we saw et F taken way more money than
Speaker 1: they should have. So the two questions are, one, do
Speaker 1: you if the market keeps going up, do you run
Speaker 1: out of losses and that tax benefit just diminishes? And
Speaker 1: then too, if the market goes down, obviously then you
Speaker 1: could you use e t F s as well. So
Speaker 1: can you talk about like the head winds of the
Speaker 1: tax Yeah, so let's take those in a couple of
Speaker 1: couple of both of those dimensions. So you're absolutely right.
Speaker 1: Over time, given an upward trending market and a loss
Speaker 1: harvesting portfolio, the portfolio becomes what we call locked up.
Speaker 1: Every position in the portfolio was at an unrealized gain.
Speaker 1: If it wasn't, you would have traded it brought the
Speaker 1: cost basis down, and so the after tax value of
Speaker 1: loss harvesting diminishes over time. How fast depends where the
Speaker 1: markets are headed, what initial cost basis you started with,
Speaker 1: what the what we call the internal volatility of the
Speaker 1: market is. But to me, that is a criticism but
Speaker 1: also a wonderful outcome. If you can buy a broad
Speaker 1: based equity portfolio loss harvested for ten years, track the market,
Speaker 1: how this tax benefit, and end up with a broadly
Speaker 1: diversified equity portfolios cost basis is significantly lower than its
Speaker 1: market value. Uh, you've won, all right, So that's not
Speaker 1: a reason not to do it ten years ago. It's
Speaker 1: but you may want to shift your focus at the
Speaker 1: end of ten years too. You know, you may have
Speaker 1: additional cash flows, you may be gifting. You may want
Speaker 1: to terminate the manager or lower the fee because you're
Speaker 1: no longer getting that tax advantage when the portfolios locked up.
Speaker 1: But that's a that's an observation, But to me, it's
Speaker 1: not a very powerful criticism. I'm saying that's the best
Speaker 1: possible outcome. We could track the market for fifteen years,
Speaker 1: end up with a locked up portfolio, have ourselves the
Speaker 1: full granular customization ability to do gifting and estate planning,
Speaker 1: whatever it may be, and continue to track the market.
Speaker 1: So it is what it is. It's a great outcome.
Speaker 1: A little bit of a red herring in terms of
Speaker 1: a criticism. Let's say the market goes down, does your
Speaker 1: does that tax advantage pitch diminished? Because now advisors like, well, yeah,
Speaker 1: I'm sitting on a bunch of losses in funds. Yeah,
Speaker 1: as you might suspect that. We we we thought deeply
Speaker 1: about that. Or it's pretty the if you if you
Speaker 1: own a fund and you want to lost harvest, you
Speaker 1: gotta get all the wayut of that fund. Okay, you
Speaker 1: have to be out of the market for thirty days,
Speaker 1: or you buy an equivalent et F and you have
Speaker 1: to worry about wash sales. If you want harvest losses
Speaker 1: in a in a diversified separate account with the granular
Speaker 1: individual stocks, you can maintain your full market exposure and
Speaker 1: harvest the losses. Uh, you can harvest, you know, so
Speaker 1: if you know you have that degrees of freedom, you
Speaker 1: have that so you can harvest more losses. Because the
Speaker 1: average market may have gone to the et F may
Speaker 1: have gone down eight percent, but the segments of the
Speaker 1: market individual securities that are down fifteen twenty, and you
Speaker 1: can harvest that out, maintain your market exposure. Continue to
Speaker 1: look at that as a as an opportunity. You cannot
Speaker 1: do any worse and an individually managed, separate account and
Speaker 1: lost harvesting than you can in an ETF portfolio, and
Speaker 1: you can certainly do better. One thing, you know, we
Speaker 1: we're watching and considering is this huge wealth transfer coming
Speaker 1: from you know, a prior generation. So one of the
Speaker 1: huge benefits I think is like considered to be the
Speaker 1: largest transfer of wealth over intrillian so I think over
Speaker 1: something over three trillion. So, by the way, is this
Speaker 1: is millennials inheriting from boomers who they're constantly like yelling at,
Speaker 1: how nice talk about in the hand that fees you. Sorry,
Speaker 1: just a side note that I can't help. But one
Speaker 1: of the huge benefits is being able to fund um
Speaker 1: one of these accounts within kind scurities. Right, So, how
Speaker 1: many of the clients new clients that you see are
Speaker 1: younger investors that are gifted individual securities and are way
Speaker 1: more prone to manage those in a passive way as
Speaker 1: opposed to how they were formerly managed. Yeah, so there's
Speaker 1: there's nuances in there that's been to start with the
Speaker 1: headline fifty in the portfolios we open five zero fund
Speaker 1: with individual securities in kind. So we're almost a lead
Speaker 1: lead pipe cinch. No brainer for funding in kind, because
Speaker 1: if you fund an e t F, you're gonna sell
Speaker 1: everything realized the gains and walk in the door and
Speaker 1: you maybe create a tax drag you'll never overcome with
Speaker 1: a feed difference. So um, there's a lot of things
Speaker 1: that go into thinking about that. Our current tax law
Speaker 1: allows stocks with unrealized gains to be stepped up and
Speaker 1: you know, and have their basis marked up to the
Speaker 1: market value if it goes through an estate planning process.
Speaker 1: So a lot of inheritors you know, uh errors uh,
Speaker 1: don't come with large unrealized gains because they've had their
Speaker 1: cost bases stepped up. But so many of the actual
Speaker 1: portfolios that we look at are coming from a historical
Speaker 1: uh individual security management, either themselves or their advisor or
Speaker 1: an sim A program that may have stocks. And we
Speaker 1: very very commercially point at that benefit and say, if
Speaker 1: you were to liquidate this portfolio and fund and ETF,
Speaker 1: it costs you seventy dollars and realized tax in taxes,
Speaker 1: and if you give it to a parametry portfolio, allow
Speaker 1: us to work it around, it'll cost you three dollars.
Speaker 1: I'm giving a hypothetical example. And this process is now
Speaker 1: kept in your portfolio. It's deferral fifty some thousand dollars
Speaker 1: in that rough example. That can work for you for
Speaker 1: as long as you need that index exposure. You need
Speaker 1: that exposure. Uh, that's just that drives a great deal
Speaker 1: of the interest. Yeah, and we mentioned we talked about
Speaker 1: thirty thirty five basis points for for these strategies. That's
Speaker 1: obviously a little bit dilutive to your parent company's sort
Speaker 1: of usual margins. And now you're looking at really scaling.
Speaker 1: How does the conversation go for how sticky these assets
Speaker 1: are that the total margin dollars might be be better
Speaker 1: over time. What are the conversations? Yeah, so you have
Speaker 1: to distinguish between the revenue realization. So the fee rate
Speaker 1: is lower, I would argue that the operating margins are not.
Speaker 1: So we may earn thirty basis points for a portfolio,
Speaker 1: twenty five or less for a very large one versus
Speaker 1: a traditional active strategy in which may earn the company
Speaker 1: fifty or sixty basis points. But if we can get
Speaker 1: to scale and we can provide that and we can
Speaker 1: have a long term portfolio. These are long term portfolio.
Speaker 1: If you have a short time arise and loss harvesting
Speaker 1: makes no sense at all because you're just going to
Speaker 1: harvest the loss and then realize the subsequent gain when
Speaker 1: you trade the portfolio. We can build a pretty compelling
Speaker 1: net present value business. So I think we'll eat Vans
Speaker 1: recognize that in two thousand three when they made the
Speaker 1: investment in Parametric. In two thousand nineteen, they recognize that.
Speaker 1: We recognize that, you know, to a much much larger degree.
Speaker 1: And and this year especially, how is the distribution conversation changed?
Speaker 1: How does this how does this more strategic combination change
Speaker 1: sort of advisors act us to what you've been providing
Speaker 1: for so many years. Yeah, I think we're turning up
Speaker 1: the volume a bit. We're trying to bring connected, uh
Speaker 1: coordinated products to the market which have fixed income and
Speaker 1: and and and equities in the same portfolio or in
Speaker 1: the same conversation. We can you know, you can do
Speaker 1: lost harvesting, and we do in our Ladder Communities Municipal
Speaker 1: bond in corporate portfolios. You can you can tax aware,
Speaker 1: rebalance the portfolio, crossed asset classes, we can provide consolidated reporting.
Speaker 1: We can bring the other wealth management solutions like the
Speaker 1: exchange fund that EAT events delivers to the market. So
Speaker 1: we're trying to put all of these like capabilities which
Speaker 1: we think are industry leading as individual products, but certainly
Speaker 1: industry leading as a combination, and we're trying to just
Speaker 1: make sure that there is understood as possible in the market. Okay,
Speaker 1: let's talk about tracking. Um it's for topic, but it's important.
Speaker 1: Tracking difference is ultimately the cost you pay because it's
Speaker 1: net all the fees, right e t f s like
Speaker 1: the Vanguard and Black Rocks, they are insanely good at tracking.
Speaker 1: They've got desks, they can do security lendings, they know
Speaker 1: how to outsmart the hedge funds for the most part.
Speaker 1: So if you look at something like v o O,
Speaker 1: it may charge three, but it's tracking is like one
Speaker 1: basis point. Tracking requires rebalances, dividends, corporate actions. How confident
Speaker 1: could I be if I was an adviser to say,
Speaker 1: you know, how much slippage am I going to get
Speaker 1: with you? Because you're not one of these gigantic experienced
Speaker 1: firms that is tracking UM with you know, much more
Speaker 1: money and has a lot more um I don't know
Speaker 1: brand name behind it. Yeah, So think about tracking is
Speaker 1: being two things. First of all, the costs that you
Speaker 1: say are always negative, you know, so they don't they're
Speaker 1: tracking only goes one direction. Your cost is going to
Speaker 1: subtract from your return. The other tracking are from your miswaiting.
Speaker 1: The purposeful miswaiting of the securities has an our view,
Speaker 1: a mean of zero. It can be positive, it can
Speaker 1: be negative, and given a long enough time, it's going
Speaker 1: to average itself out if you're doing this consciously. And
Speaker 1: so we we we create let's it's typical to have
Speaker 1: the tracking error. Let's just use that term, which is
Speaker 1: think about it as the kind of a common boundaril
Speaker 1: of about fifty basis points. So we're not even in
Speaker 1: the same game as the v Oh, we're not even
Speaker 1: in the same game. Let me pause there. I just
Speaker 1: want to say, let's assume I just wanted the SMP
Speaker 1: because I know I'm going to pick these thocks or
Speaker 1: eliminate a couple that are gonna it's my tracking. But
Speaker 1: for the rest I want to make sure that I'm
Speaker 1: getting every last bit of juice from the SMP index,
Speaker 1: and I don't want any slippage for the rest. But
Speaker 1: so let's just say I just wanted SMP from you.
Speaker 1: Could you deliver tracking that is in line with a
Speaker 1: Van Garter black Rock. You wouldn't want to hire us,
Speaker 1: I shouldn't hire us. Yeah. So a family office early
Speaker 1: days looked at me when I explained tracking air and
Speaker 1: he says, look, you're whipping the wrong horse. He says,
Speaker 1: I'm going to be invested in this twenty years. And
Speaker 1: whether or not I get the SMP plus ten or
Speaker 1: minus ten or plus thirty or minus thirty, that doesn't
Speaker 1: matter to me. I'm trying to create and build my wealth.
Speaker 1: I'm trying to protect it. And if I can get
Speaker 1: fifty sixty basis points of tax value and that tracking error,
Speaker 1: that's the right horse. Whether or not I'm up five
Speaker 1: or basis points more fiber basis points less than a
Speaker 1: than an ultimate arbitrary market measure, that's the wrong horse.
Speaker 1: But you do all those things right. You can take
Speaker 1: care of the corporate action solutely, every detail, reinvest the
Speaker 1: dividends and markets and international we do, we do, We
Speaker 1: do a little less liquid, right, Yeah, we do a
Speaker 1: lot increasingly the portfolios that we invest in. Our global
Speaker 1: investors advisors want to create a global beta portfolio tracking
Speaker 1: a global you know, all world index. Why do you
Speaker 1: think that's happening? Well, I think that again. You you
Speaker 1: want to you want to give yourself as many degrees
Speaker 1: of freedom as you can. So instead of just investing
Speaker 1: in the SMP market, you can invest in the FA market.
Speaker 1: International is not having a good run. Later, cross sectional volatility,
Speaker 1: I'll get nerdy on you. So cross sectional volatility when
Speaker 1: Japan's up, UK maybe down, when securities in the tech
Speaker 1: sector in in the United States are up, you know,
Speaker 1: maybe the German banks are down. So you can again
Speaker 1: have as a quant you can have a more successful
Speaker 1: outcome of tracking this diverse index and harvesting losses across it.
Speaker 1: So you've gone, you've you've expanded your tools set in
Speaker 1: your granular, separate account and so that makes a lot
Speaker 1: of sense. And basically, since you've been running like a
Speaker 1: ten billion a year net inflow for that custom core,
Speaker 1: you know, do you see that accelerating with you know,
Speaker 1: lower account minimums. Yeah, I don't necessarily think lower account
Speaker 1: minimums are are going to drive and maybe as much
Speaker 1: as some. And I'm not a big believer in the
Speaker 1: e t F killer and kind of driving this down.
Speaker 1: I think you need to be an investor with a
Speaker 1: certain type of portfolio and a certain tax sensitivity, and
Speaker 1: a certain relationship with the advisor. So many people may
Speaker 1: differ from me on that um I think this is
Speaker 1: ultimately a advisor driven high net worth market product, but
Speaker 1: there's a lot of opportunity for us to continue to
Speaker 1: grow and faster. I think of it as this. You know,
Speaker 1: you guys know this better than me, and you can
Speaker 1: quote the statistics. But every year there's a flow of
Speaker 1: money toward index base most of them and e t
Speaker 1: f s and opening mutual funds into index based strategies,
Speaker 1: both equity and fixed income, hundreds of billions of dollars
Speaker 1: parametric and our competitors. We divert off of that stream,
Speaker 1: a small percentage of that into custom separate accounts uh where,
Speaker 1: And the people who choose it are choosing it rationally
Speaker 1: because the value to them is much greater than the
Speaker 1: tracking air in the feast. We can, through education and
Speaker 1: continued innovation, continue to divert off more and more of
Speaker 1: that every year and parametric. We want our share. We
Speaker 1: want to continue to grow market share and b the
Speaker 1: market leader, but the others will get it as well.
Speaker 1: How big can it get? You can get a lot
Speaker 1: bigger than it is, and it should in my view.
Speaker 1: But I would have told you that in nineteen and
Speaker 1: then you know we're a we're a three d billion.
Speaker 1: But that's a thirty year road. Yeah, that's interesting. Yes,
Speaker 1: By launched the ninete So you guys are actually just
Speaker 1: as old twenty six years ash or whatever, early nineties.
Speaker 1: You're not based in New York. You're based in Seattle,
Speaker 1: that's right, So talk to us about what you're in
Speaker 1: Seattle in the early nineties, which is like, that's like
Speaker 1: being in the nucleus of one of the greatest musical
Speaker 1: rock renaissance is known demand known as grunge. Can tell
Speaker 1: me some stories. Oh, well, you know, I graduated from
Speaker 1: college the University of Washington nineteen ninety and all of
Speaker 1: the bands that you're talking about, Nirvana, you know, Pearl Jam,
Speaker 1: all of those were just starting to show up in
Speaker 1: the clubs and so you know, as a young person,
Speaker 1: we would we would find ourselves. That shows that in hindsight,
Speaker 1: we would think that was incredible and we could tell
Speaker 1: these great stories. At the moment, we may have not
Speaker 1: a predicative. You were around when Eddie Vetter used to
Speaker 1: climb on top of the roof the ceiling and like
Speaker 1: dropped down into the crowd. Right, Yeah, seeing Alison change,
Speaker 1: he got wealthy and he's like, yeah, I I'm not
Speaker 1: going to do yeah. Yeah, well now he plays Safeco
Speaker 1: Field and three nights and and uh, yeah, you can't
Speaker 1: do that and brings out the last time I was there,
Speaker 1: he brought out to teach his children's teacher onto the stage.
Speaker 1: It's a different world. Um. Yeah, the Crocodile Cafe. I
Speaker 1: don't know if you guys come there, you know, one
Speaker 1: of the you know, seeing seeing some of the initial
Speaker 1: bands there. I'm going there in nineteen. It was a
Speaker 1: great fun. Well again, you don't know that. You're twenty
Speaker 1: two year old kid. You're trying to find a job
Speaker 1: and you're going to music and you know, I mean
Speaker 1: when we showed up, I think Seattle showed up on
Speaker 1: the cover of Time magazine and we became this hot
Speaker 1: place and everybody was wearing their plaid and and uh,
Speaker 1: we kind of sense. This was kind of cool. But
Speaker 1: you know, the Seattle music scene continues to be interesting.
Speaker 1: Do you take some of that into your job, some
Speaker 1: of that like grunge, rebellious spirit. Yeah, I don't know.
Speaker 1: We do take Seattle and I do. Yeah, I was there.
Speaker 1: I saw Pearl Jam when they played Safegal last year. No, now,
Speaker 1: I'm you know, fifty something with my wife and trying
Speaker 1: to leave leave earlier teacher, Yeah, cheering for And you
Speaker 1: said earlier your your neighbor opened for Pearl James first year. Yeah.
Speaker 1: So my neighbor, who's now a vice president of Microsoft,
Speaker 1: was the lead singer in a band that opened for Mike.
Speaker 1: Uh so. But again, even looking at him across the fence,
Speaker 1: now you think what happened to you? You know, at
Speaker 1: one point you were at the epicenter and uh but
Speaker 1: it's great fun. But the audacity of Seattle, Amazon, Starbucks, Microsoft,
Speaker 1: the business building and it does wash over you. You
Speaker 1: do have a sense that you can do something, maybe
Speaker 1: on a national scale or global scale, where you wouldn't
Speaker 1: from someone from Portland. Yeah, well, there's a little rivalry.
Speaker 1: He's a husky, I'm a duck. Oh no, you didn't
Speaker 1: tell me that at the beginning this all off, who's
Speaker 1: from Portland? So he just rattled off, like so many
Speaker 1: cool people, Well you know Nike Adidas, like we'll throw back.
Speaker 1: It's yeah, it's just a friend. You know the Ducks
Speaker 1: one this year though, the football game, that was a
Speaker 1: great Yeah. You know, I wanted to actually ask you,
Speaker 1: like one final question, which was this started with a
Speaker 1: conversation with the family office way back. When are you
Speaker 1: guys still working with that family there's still a client today.
Speaker 1: I mean that's a layup question. Thank you for asking,
Speaker 1: but yes, twenty seven years later, that group is still
Speaker 1: works with it. Brian Morgan, thank you so much for
Speaker 1: joining us on Trillians. Thank you for having me, Thanks
Speaker 1: for listening to Trillions until next time. You can find
Speaker 1: us on the Bloomberg term, Bloomberg dot com, Apple Podcasts, Spotify,
Speaker 1: and wherever else you'd like to listen. We'd love to
Speaker 1: hear from you. We're on Twitter, I'm at Joel Weber Show,
Speaker 1: He's at Eric Ballcunas. You can find Morrigan at m
Speaker 1: Barnes six and Parametric at Parametric LLC. Trillions is produced
Speaker 1: by Magnus Hendrickson. Francesca Levy is the head of Bloomberg Podcast.
Speaker 1: Bye